Now Let’s Really Reform Governance

By John Carver

August 15, 2011

This article was originally published in the January-February 2005 issue ofBoard Leadership,

Corporate governance reform has become a growth industry around the world. In most countries, new expectations about transparency, conflicts of interest, and composition have taken the voluntary form of “conform or explain.” In the United States, reforms came in the more authoritative form of legislation-the Sarbanes-Oxley Act of2002 (SOX), sponsored by Senator Paul S. Sarbanes and Congressman Michael G. Oxley. The law was passed in response to various recent corporate debacles. It is not the first such reform, nor will it be the last, although due to its legal force it is the most conspicuous in recent history. Although SOXapplies to listed companies, many boards of nonprofit organimtions and units of local government-mistakenly thinking SOX is the last word in good governance-have tried to apply its provisions to their own situations voluntarily. In fact, SOX does improve many widespread corporate practices, but it is not a complete governance system and in fact does nothing to address the nature of corporate governance itself: In other words, SOX along with less legalistic reforms around the world, provides some useful patches for the primitive state of corporate governance but leaves it only in a newly patched condition. The following article originally appeared in Directors Monthly.

Now that most listed companies have their Sarbanes-Oxley compliance in place, it might,be a good time to consider actual governance reform. Sarbanes- Oxley goes far to protect investors from governance with respect to transparency failures and conflicts of interest, but little to address the poverty of governance as a caremy crafted leadership function.

Compliance costs massive legal fees and executive time, but the implication that deficiencies of governance have finally been addressed threatens even greater harm. Like much of law, Sarbanes-Oxley protects against misconduct, but does not cause excellent conduct. Obeying traffic laws is important, but doing so does not constitute expert driving.

The real governance reform needed is not attained by pursuing “best practices,” Sarbanes-Oxley compliance, or by any of the codes extant in the world today. Meaningful reform-reform that the most authoritative element in corporate life surely warrants-can come about only if based on sound theory. The importance of a conceptually coherent theoretical foundation is accepted in virtually all other important pursuits from architecture to aeronautics to medicine.

What would a theory of governance look like and what changes might it cause in boardrooms? Here are a few of the tangible outcomes that flow from the principles of the Policy Governance model:

Boards-and those who regulate or deal with boards-must conceive of the board as a distinct link in the chain of moral authority that begins with shareholders. To go beyond mere lip service to this fact, board-centrism must replace CEO-centrism and the board must become a commander, not an advisor. Boards, not CEOs, are the appropriate link to shareholders.

There must be an end to the governance-management entanglement. That entanglement can be caused by overlapping personnel or by conceptual fuzziness in job design. Overlapping personnel is as unacceptable when meddling directors make themselves into executives-one-step-removed as when real executives sit on their own board.

The board as a whole, not directors as individuals, possesses enormous ownerrepresentative authority. That means no one director has authority over management, including the director chosen to lead the governance parade-the chair (when not the CEO). Managers throughout their careers are accustomed to working for a boss; but if directors think that way, responsible governance will forever elude them.

Despite the obligation of the board to speak authoritatively only as a group, the chair remains a crucially important officer. But no longer is the chair even subtly the CEO’s superior, for he or she will have been transformed into a true “chief governance officer”-so much so to merit the introduction of CGO as the more descriptive title. In this role, the CGO’s task is to see to it, on behalf of the board, that the board performs the job it has set for itself (notice the servant-leadership circularity) with wisdom and with no less precision than is demanded of every technical function within the company.

Committess of the board would be seen not as authorities in their own right, but as extensions of the board, therefore accountable to the board, and under the authority of the board. It would be a board decision whether even to have committees, and never would a board committee be allowed to get between the board and its CEO in any instructional way. Sarbanes-Oxley and other codes virtually force a committee structure rather than leaving that up to each accountable board, a flaw as real as if the board were to jump levels and tell the CEO how he or she must establish delegation specifics about a plant manager and HR department.

It would be a board decision whether even to have committees, and never would a board committee be allowed to get between the board and its CEO in any instructional way. Sarbanes-Oxley and other codes virtually force a committee structure rather than leaving that up to each accountable board, a flaw as real as if the board were to jump levels and tell the CEO how he or she must establish delegation specifics about a plant manager and HR department.

The board, though meeting only as a part-time body, would hold and exercise its superior authority full time and proactively. It would not see itself as a standby authority for when things go wrong, any more than a CEO should see himself or herself to be authoritative only when subordinates’ areas of responsibility fall into disarray. The board would design its job to be the owners’ authoritative, on-site voice rather than management’s helpers, adversaries, or quality-control inspectors.

As the highest corporate unit-save shareholders, of course-the board must dejiw and demand certain corporate peerformame rather than poke and probe what management brings it. It would see itself more as the initial authority than the “final authority,” that is, not a reactive approver of managers’ recommendations. Proactively setting expectations must replace reactively “asking good questions.” This calls for boards to be in charge of their own jobs, agendas, and all. Governing a company requires first that a board be able to govern itself.

Yet the board must not become supermanugement, thereby emusculating executives. Balancing under- and overcontrol calls for far more carefully designed separation of roles than is normal today, not the largely personalitybased negotiation of roles. The board’s total accountability for all corporate behavior, achievement, and risks demands the studied application of its authority over all corporate functions.

To be powerfully in control without meddling, the board must operate from principles designed for governance, not ones simply lifled from management. Governance, unlike management, involves group supervision of an individual, not individual supervision of a group. It entails the crucial interface with a strong chief executive, crafting that role neither as a high-salaried clerk through overcontrol nor as a tsar or tsarina through undercontrol. While the past warns us against undercontrol, without a more rigorous design of governance, current trends in board activism are forewarning of the stultifying evils of overcontrol.

A board must view itselfnotjust as a part-time, high-level instance of what directors typically already understand--management. It is a completely different job that requires different language, different reporting formats, and different forms of decision making, along with the independence of mind and transparency of values on which most codes focus. Though it might seem counterintuitive in light of time-honored traditions, it calls for greater intimacy between directors and shareholders than between directors and executives.

One aspect of the new governance is that the board would concern itself foremost with prescription of company economic performance in terms of shareholder value, the “ends.” That is, the board would be concerned primarily with what the company is for rather than with what it does, as John Argenti expressed the distinction. But with regard to what the company does, it would leave to the CEO the authority to use whatever methods, conduct, strategies, personnel, and other “means,” except those the board has carefully put off limits.

Based on the concept that decisions in a company can be seen in terms of levels within levels, the board would make its decisions in their broadest iteration. That is, the board would decide “ends” and limits on “means” as broad policy directives, leaving to the CEO the right to use any reasonable interpretation of the board’s words.

Governance exists not to add value to management, but to add value to the owners’ voice over that which they own. As an extension of shareholders, corporate governance is a representative arena of investing rather than a special case of the management art. Consequently, the nature and mentality of governance properly construed is not management one step up, but informed ownership one step down.

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Reprinted with permission of the publisher from Directors Monthly, November 2004, pages 16-1 7, a publication of the National Association of Corporate Directors WACD), 1133 21st Street W, Suite 700, Washington, DC20036, www.nacdonline.org.